The impact of bond market liberalization on accounting conservatism

In a quasi-natural experimental setting in which Bond Connect allows foreign investors to trade in the Chinese interbank bond market, we predict and find that firms subject to the program increase their accounting conservatism. Further analyses suggest that the increase is concentrated among firms with higher litigation risk, more corporate site visits and greater media attention from overseas, suggesting that foreign bond investors affect firms through the channel of bondholder litigation and monitoring. Additionally, we document that improvement in conservatism is more pronounced when foreign investors participate more and for firms with looser issuance criteria. We also find that enhanced conservatism results in a lower cost of debt for bonds in the liberalized market and those of the same issuers in the nonliberalized market, as well as lower overinvestments and fewer dividends. In addition, firms show greater conservatism in other forms of public disclosure. Together, these findings suggest that firms enhance accounting conservatism to facilitate foreign bond investors’ assessment of credit risk.